Tax Accounting: Unravelling the Mystery of Income Taxes

(Second Revised Edition)

Why this book?
Since the publication of the first edition of the book in 2015, numerous changes have taken place in the world of tax
accounting. In addition to compressed close cycles and new reporting considerations and standards, companies
are facing challenges due to increased regulatory scrutiny over income tax disclosures and account balances.
At the same time, today’s complex business and tax environment has resulted in ever-increasing demands for
transparency and tax reporting standards at all levels. Public deficits due to COVID-19 support packages will only
trigger more public attention to tax affairs. Moreover, guidance has been issued on good tax governance and/or
tax risk management, and tax reporting and compliance by the UN Principles for Responsible Investment and the
newly developed GRI 207: Tax 2019, which is the first public global standard for comprehensive tax disclosures.As
with the previous edition, the basis of the book remains a ten-step methodology for accounting for income taxes,
which can be applied in jurisdictions across the globe. The methodology presented is primarily based on the global
accounting standard, namely the International Financial Reporting Standards (IFRS), with specific attention to US
GAAP and some local standards. This methodology is comprehensive and complete. This updated edition covers
the latest IFRS and IFRIC guidance for income taxes. Essentially, all chapters have been rewritten to cover new
developments such as (i) digital services taxes; (ii) IFRIC 23 Uncertainty over Income Tax Treatments; (iii) tax
accounting and tax risk management checklists; (iv) the impact of technology and new transparency initiatives; and
(v) the impact of COVID-19 on companies.

The impact of COVID-19 on the results of companies’ operations is discussed, consideration being given to the
challenges the current market volatility may present for companies closing their financial statements. Other issues
addressed include deferred tax assets recognition, impairment, increased need of cash by a group and distribution
of dividends, and government grants and reliefs. Finally, a case study gives the reader a better understanding on
how to arrive at the correct tax figures and disclosure notes, and in doing so truly unravels the mystery of how the
reported income taxes can be explained.

Benefitting from the extensive insight and experience of the authors, the book will serve as a valuable reference
tool to assist tax accountants, (tax) auditors, tax authorities, legislators, tax practitioners, and tax managers and
directors in their daily practice, as well as a guideline for newcomers to the tax accounting environment.

Title: Tax Accounting: Unravelling the Mystery of Income Taxes

(Second Revised Edition)
Editor(s): Anuschka Bakker, Tjeerd van den Berg
Date of publication: October 2020
ISBN: 978-90-8722-653-4 (print/online), 978-90-8722-654-1 (ePub),
978-90-8722-655-8 (PDF)
Type of publication: Book
Number of pages: 464
Terms: Shipping fees apply. Shipping information is available on our website
Price (print/online): EUR 125 / USD 150 (VAT excl.)
Price (eBook: ePub or PDF): EUR 100 / USD 120 (VAT excl.)
Order information
To order the book, please visit www.ibfd.org/IBFD-Products/shop. You can purchase a copy of the
book by means of your credit card, or on the basis of an invoice. Our books encompass a wide
variety of topics, and are available in one or more of the following formats:

• IBFD Print books

• IBFD eBooks – downloadable on a variety of electronic devices
• IBFD Online books – accessible online through the IBFD Tax Research Platform

IBFD, Your Portal to Cross-Border Tax Expertise

IBFD
Visitors’ address:
Rietlandpark 301
1019 DW Amsterdam
The Netherlands

Postal address:
P.O. Box 20237
1000 HE Amsterdam
The Netherlands

Telephone: 31-20-554 0100

Email: info@ibfd.org
www.ibfd.org

© 2020 IBFD

All rights reserved. No part of this publication may be reproduced, stored in

a retrieval system or transmitted in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without the written prior
permission of the publisher. Applications for permission to reproduce all or part
of this publication should be directed to: permissions@ibfd.org.

Disclaimer
This publication has been carefully compiled by IBFD and/or its author, but
no representation is made or warranty given (either express or implied) as to
the completeness or accuracy of the information it contains. IBFD and/or the
author are not liable for the information in this publication or any decision or
consequence based on the use of it. IBFD and/or the author will not be liable
for any direct or consequential damages arising from the use of the information
contained in this publication. However, IBFD will be liable for damages that
are the result of an intentional act (opzet) or gross negligence (grove schuld)
on IBFD’s part. In no event shall IBFD’s total liability exceed the price of the
ordered product. The information contained in this publication is not intended
to be an advice on any particular matter. No subscriber or other reader should
act on the basis of any matter contained in this publication without considering
appropriate professional advice.

Where photocopying of parts of this publication is permitted under article 16B of the 1912
Copyright Act jo. the Decree of 20 June 1974, Stb. 351, as amended by the Decree of
23 August 1985, Stb. 471, and article 17 of the 1912 Copyright Act, legally due fees must
be paid to Stichting Reprorecht (P.O. Box 882, 1180 AW Amstelveen). Where the use of
parts of this publication for the purpose of anthologies, readers and other compilations
(article 16 of the 1912 Copyright Act) is concerned, one should address the publisher.

ISBN 978-90-8722-653-4 (print)

ISBN 978-90-8722-654-1 (eBook, ePub); 978-90-8722-655-8 (eBook, PDF)
NUR 826
 Foreword

When we published the first edition of this book in 2015, we presented a

ten-step methodology for accounting for income taxes that can be applied in
every jurisdiction around the globe. The methodology presented is primarily
based on the global accounting standard, namely the International Financial
Reporting Standards (IFRS), with specific attention to US GAAP and some
local standards. This methodology is comprehensive and complete. At that
point in time, the general public was also increasingly interested in the
fiscal position of companies. Back then, we mentioned as an example the
OECD BEPS developments, for instance in relation to country-by-country
reporting and the disclosure of payments of income taxes by companies to
the respective local authorities that might become an element of financial
statements in the near future.

It has been only five years, but so many changes have taken place since
then. On top of compressed close cycles, as well as new reporting consid-
erations and standards, companies are facing challenges due to increased
regulatory scrutiny over income tax disclosures and account balances. In
today’s increasingly complex business and tax environment, the demands
for transparency have never been stronger. An ever-wider variety of stake-
holders show an interest in how tax affairs are being managed and how
much companies pay. Public deficits due to COVID-19 support packages
will only trigger more public attention to tax affairs. Further, the guidance
with respect to tax reporting increased at EU, OECD and jurisdictional
level. In addition, guidance has been issued on good tax governance, tax
risk management, and tax reporting and compliance by the UN Principles
for Responsible Investment (PRI). Most recently, increased attention by
the Global Reporting Initiative for taxes resulted in the newly developed
GRI 207: Tax 2019 – the first public global standard for comprehensive tax
disclosures.

The basis of this book is still the ten-step methodology for accounting for
income taxes that can be applied in every jurisdiction around the globe.
The chapters of the book, written by experts in the field, aim to apply and
explain these ten steps.

This updated publication covers the latest IFRS and IFRIC guidance for
income taxes.

Essentially, all chapters have been rewritten to cover new developments,

such as: (i) digital services taxes; (ii) IFRIC 23 Uncertainty over Income

v
Foreword

Tax Treatments; (iii) tax accounting and tax risk management checklists;
(iv) the impact of technology and new transparency initiatives; and (v) the
impact of COVID-19 on companies.

It is no surprise that the coronavirus (COVID-19) has impacted and will

continue to impact the results of companies’ operations. Given the volatility
of market conditions, closing financial statements may be particularly chal-
lenging for many companies. Authors provide guidance on how companies
can deal with COVID-19 from a tax accounting and reporting perspective.
Items such as deferred tax assets recognition, impairment, increased need
for cash by the group and the distribution of dividends, government grants
and reliefs are addressed in this publication.

We hope this publication will be useful to all tax professionals, (tax)

accountants, (tax) auditors and interested finance professionals working in
the academic, consultancy or business environment.

Anuschka Bakker, Manager VAT, Transfer Pricing and Specialist Knowledge

Group, IBFD
Tjeerd van den Berg, Partner, Netherlands TRS Practice & EMEA Tax Ac-
counting Services Leader, PwC

vi
 Table of Contents
Foreword v

Chapter 1: Introduction to Tax Accounting 1

Tjeerd van den Berg

1.1. Introduction 1

1.2. Importance of accounting for income taxes 2

1.3. Primary tax accounting terminology 3

1.4. How are income taxes accounted for? 6

1.5. Other factors affecting tax reporting: Looking

beyond the accounting requirements 13
1.5.1. Introduction 13
1.5.2. Fair share of taxes, non-financial reporting and
pressure from investors 15
1.5.2.1. Publish What You Pay 15
1.5.2.2. Work by non-governmental organizations 16
1.5.2.3. The alphabet soup 18
1.5.2.4. The GRI standard on tax and payments to
governments 20
1.5.2.5. The UN Principles for Responsible Investment 25
1.5.3. Regulatory industry, country-by-country and other
reporting requirements 25
1.5.3.1. The Extractive Industries Transparency Initiative 26
1.5.3.2. US development in CbC reporting 28
1.5.3.2.1. Proposed update from FASB to income tax disclosures 28
1.5.3.2.2. International exchange of CbC reports 29
1.5.3.2.3. Recent developments in the United States 30
1.5.3.3. Relevant EU directives 31
1.5.3.3.1. EU Directives on Accounting and Transparency 32
1.5.3.3.2. EU Capital Requirements Directive 34
1.5.3.3.3. European Non-Financial Reporting Directive 35
1.5.3.3.4. European Directive on Mandatory Disclosure Rules
(DAC6) 36
1.5.3.4. Transfer pricing documentation under the OECD
Guidelines 37
1.5.4. Conclusion 40

vii
Table of Contents

1.6. International Financial Reporting Standards 41

1.6.1. Introduction 41
1.6.2. Why are International Financial Reporting Standards
developed? 41
1.6.3. The convergence project 43
1.6.4. The structure of the IFRS Foundation 44
1.6.4.1. The Board 45
1.6.4.2. IFRS Foundation 46
1.6.4.3. IFRS Foundation trustees 46
1.6.4.4. IFRS Foundation monitoring board 47
1.6.4.5. IFRS advisory council 48
1.6.4.6. IFRS Interpretations Committee 48
1.6.4.7. Accounting Standards Advisory Forum 49
1.6.5. Financial reporting standards 49
1.6.5.1. Introduction 49
1.6.5.2. The due process of IFRS 50
1.6.5.3. The due process of IFRIC interpretations 51
1.6.6. Conclusion 52

Chapter 2: Definition of Income Taxes 55

Eva Eberhartinger, Alexandra Patloch-Kofler
and Elisabeth Höltschl

2.1. Introduction 55

2.2. Scope of IAS 12 55

2.3. Income taxes in the statements and analysis 58

2.4. Income taxes 59

2.5. Specific forms of taxation 61

2.5.1. Income tax 61
2.5.2. Withholding tax 62
2.5.3. Business tax 63
2.5.4. Tonnage tax 65
2.5.5. Mining tax 66
2.5.6. Interest payments and penalties 67
2.5.7. Alternative minimum taxes 69
2.5.8. Tax on value added 70
2.5.9. Taxes beyond the scope of IAS 12 70
2.5.10. Digital services taxes 70

viii
 Table of Contents

2.6. Differences between IFRS and US GAAP 72

2.7. Developments with respect to COVID-19 73

Chapter 3: Book-to-Tax Differences: Permanent

and Temporary 75
Eduardo Flöring and Konstantin Smolsky

3.1. Introduction 75

3.2. Tax returns and reconciliation of financial statements 81

3.3. Adjustment of profit for tax purposes and the

performance statements 82

3.4. Recovery of assets and settlement of liabilities 84

3.5. Impact of COVID-19 on IFRS reporting and

deferred tax calculation 86

3.6. Frequently asked questions 88

Chapter 4: Current Tax and Prior Year Adjustments 91

Khadija Baggerman-Noudari

4.1. Introduction 91

4.2. The process 92

4.3. Calculate current tax for the year 93

4.3.1. Calculate taxable income for the year 93
4.3.1.1. Recognition of current tax liabilities and
current tax assets 96
4.3.2. Tax rates 96
4.3.3. Tax incentives 99
4.3.4. Uncertain tax positions 101
4.3.5. Tax loss carry-back claims 103

4.4. Calculate any prior year adjustments 106

4.4.1 Prior year adjustments 106
4.4.2. Change in accounting estimate vs. error 110

ix
Table of Contents

4.5. Reconcile tax accounts 113

4.5.1. Introduction 113
4.5.2. Balance sheet classification 115
4.5.3. Discounting 116

4.6. Conclusion 117

Chapter 5: Deferred Taxes 119

Ronel Fourie

5.1. Introduction 119

5.2. Origin of deferred tax assets 120

5.3. Overview of deferred tax assets and liabilities 121

5.3.1. Recognition 121
5.3.2. Measurement 123
5.3.3. Presentation 124

5.4. Practical approach to calculating deferred tax 126

5.5. Basic principles of carrying amount 126

5.6. Tax base as the basis for calculating deferred tax 127
5.6.1. Tax base of an asset 128
5.6.2. Tax base of a liability 130
5.6.3. Tax base of revenue received in advance 132
5.6.4. Uncertainty in determining the tax base 133

5.7. Tax base without a carrying amount 133

5.8. Calculate the temporary differences 135

5.8.1. Temporary difference 135
5.8.2. Taxable temporary differences 136
5.8.2.1. Assets 136
5.8.2.2. Liabilities 137
5.8.2.3. Other examples of taxable temporary differences 137
5.8.3. Deductible temporary differences 138
5.8.3.1. Assets 138
5.8.3.2. Liabilities 139
5.8.3.3. Other examples of deductible temporary differences 139
5.8.4. Other examples of temporary differences 140

x
 Table of Contents

5.9. Recognition criteria and initial recognition

exemptions 141
5.9.1. Initial recognition exemption 141
5.9.2. Initial recognition of goodwill exempted
from deferred tax 146
5.9.3. Exemption from recognizing outside basis
deferred tax 146
5.9.4. Exemption from recognition of deferred tax assets 146

5.10. Manner of expected recovery 146

5.10.1. Substantively enacted tax rates 146
5.10.2. Tax rates based on manner of recovery 147
5.10.3. Recovery of investment property 150
5.10.4. Different tax rates for levels of taxable profit 151

5.11. Reconcile movements in deferred tax balances 152

5.11.1. Disclosure of deferred tax movements 152
5.11.2. Accounting for a deferred tax movement 153
5.11.2.1. Deferred tax movements in the income statement 153
5.11.2.2. Deferred tax movements in other comprehensive
income 154
5.11.2.3. Deferred tax movements in equity 154
5.11.3. Disallowance of discounting 155
5.11.4. Deferred tax on capital losses 155

5.12. Practical issues 155

5.12.1. Investment tax credits 155
5.12.2. Deferred tax on compound financial instruments 158
5.12.3. Divestments: Rollover relief 158
5.12.4. Intra-group transactions 159
5.12.5. Tax consideration during uncertain times
(COVID-19) 161

Chapter 6: Deferred Tax Asset Recognition 163

Marcin Partyka and Jorge Molina

6.1. Introduction 163

6.2. Deferred tax assets 164

6.2.1. Relevant deferred tax assets and GAAPs 164
6.2.2. Recognizing a deferred tax asset 166

xi
Table of Contents

6.3. Deferred tax assets on unused tax losses and credits 168
6.3.1. Background 168
6.3.2. The threshold: “Probable” 169
6.3.3. History of recent losses 176
6.3.4. Convincing other evidence 178
6.3.5. Specific tax regimes 180

6.4. Tax rate to be used 182

6.5. Discounting 184

6.6. Netting 185

6.7. The impact of the COVID-19 virus outbreak on

the recognition of deferred tax assets as examples
of non-recurrent events that still carry significant
uncertainty to the future 186

6.8. Simplified checklist for deferred tax assets

recognition 187

6.9. Frequently Asked Questions 188

Chapter 7: Tax Exposures 191

Koen De Grave, Scott Miller and Paul Pellegrine

7.1. Introduction 191

7.2. Basic theory and technical guidance 193

7.2.1. Identification of uncertain tax treatments 194
7.2.1.1. What are uncertain tax treatments? 194
7.2.1.2. To consider uncertain tax treatments separately
or together (determine unit of account) 196
7.2.2. Recognition 198
7.2.2.1. Evidence to support recognition 200
7.2.2.2. Detection risk 201
7.2.2.3. Tax opinions 202
7.2.2.4. Uncertainties related to valuation 203
7.2.2.5. Temporary differences 204
7.2.3. Measurement 205
7.2.3.1. Measurement under IFRS – Expected value method 206

xii
 Table of Contents

7.2.3.2. Measurement under IFRS – Most likely

amount method 207
7.2.3.3. Measurement under US GAAP 208
7.2.3.4. Examples of US GAAP and IFRS recognition and
measurement 209
7.2.3.4.1. Example of transfer pricing-related uncertain
tax position 209
7.2.3.4.2. Binary tax position 212
7.2.4. Subsequent events 213
7.2.5. Effective settlement and statute of limitations 215
7.2.6. Interest and penalties 218
7.2.6.1. Accounting policy election under US GAAP 218
7.2.6.2. Judgement under IFRS 220
7.2.7. Presentation in the statement of financial position 221
7.2.8. Financial statements disclosures 221

7.3. Conclusion 223

Chapter 8: Disclosure Notes 225

Patrick van Gerven and Frank Imming

8.1. Introduction 225

8.2. Presentation versus disclosure 226

8.3. Presentation and disclosure requirements IAS 12 230

8.3.1. Introduction 230
8.3.2. Presentation 231
8.3.2.1. Offsetting current taxes 231
8.3.2.2. Offsetting deferred taxes 233
8.3.2.3. Tax expense 234
8.3.2.4. Exchange differences on deferred foreign tax
liabilities or assets 234
8.3.3. Disclosure 236
8.3.3.1. Total tax expense (income) 237
8.3.3.2. Effective tax rate reconciliation 239
8.3.3.3. Tax rates 242
8.3.3.4. Tax via equity and other comprehensive income 244
8.3.3.5. Overview of tax losses/non-recognized deferred
tax assets 246
8.3.3.6. Investments in subsidiaries, branches and associates
and interests in joint arrangements 247

xiii
Table of Contents

8.3.3.7. Deferred taxes 249

8.3.3.8. Discontinued operations 253
8.3.3.9. Income tax consequences of dividends 255
8.3.3.10. Business combinations 259
8.3.3.11. Future taxable income 260
8.3.3.12. Tax contingencies and events after the reporting
period 262

8.4. Non-IAS 12 presentation and disclosure

requirements 265
8.4.1. Introduction 265
8.4.2. IAS 1: Presentation of financial statements 265
8.4.3. IAS 7: Statement of cash flows 274
8.4.4. IAS 10: Events after the reporting period 277
8.4.5. IFRS 3: Business Combinations 278
8.4.6. IFRS 8: Operating Segments 278

8.5. Conclusion 281

Chapter 9: Special Items 283

Mark Koek and Tjeerd van den Berg

9.1. Introduction 283

9.2. Initial recognition 283

9.2.1. General rule of initial recognition 284
9.2.2. Mergers 287
9.2.3. Assets carried at fair value 290
9.2.4. Change in tax status of the entity 290
9.2.5. Migration of an entity 292
9.2.6. Subsequent changes in value: Impact on the initial
recognition exemption 293

9.3. Outside basis differences 294

9.3.1. What is an outside basis difference? 294
9.3.2. Calculating deferred taxes on outside basis
differences 297
9.3.2.1. Impact of local legal requirements 298
9.3.2.2. Impact of local tax treatment of the shareholder 298
9.3.2.3. Impact of tax treaties 300
9.3.3. Deferred tax assets in relation to unremitted
retained earnings 301

xiv
 Table of Contents

9.3.3.1. Withholding taxes and deferred tax assets on

unremitted retained earnings 301
9.3.3.2. Impairment of investments and deferred tax assets
on unremitted retained earnings 303

9.4. Business combinations 304

9.4.1. Basic principles 304
9.4.2. Acquisition method 306
9.4.2.1. Identify the acquirer 307
9.4.2.2. Determine the acquisition date 307
9.4.2.3. Recognize and measure assets and liabilities 308
9.4.2.4. Recognizing and measuring goodwill or bargain
purchase 309
9.4.3. Examples of business combination 310
9.4.3.1. Examples of purchase price allocation 310
9.4.3.2. Example of deferred tax in a share deal 311
9.4.3.3. Example of deferred tax in an asset deal 314
9.4.3.4. Example: Asset deal and share deal in one
transaction 317
9.4.3.5. Example: Identifiable assets – Fair value,
no tax basis 319
9.4.3.6. Example: Net operating losses or tax credits in
a business combination 321
9.4.4. Specific disclosures for business combinations 323

9.5. Share-based payments 324

9.5.1. Different share-based payment transactions 324

9.5.2. Objective and examples of share-based payment

accounting (IFRS 2) 326
9.5.2.1. Significant dates 327
9.5.2.2. Equity-settled share-based payment transactions 327
9.5.2.3. Cash-settled share-based payment transactions 330
9.5.3. Tax accounting consequences of share-based
payment transactions 332
9.5.3.1. Tax accounting paragraphs 333
9.5.3.2. Tax accounting: Share-based payment transactions –
Examples 334
9.5.3.3. Cash-settled share-based payments: Example 339

xv
Table of Contents

9.6. Other comprehensive income and discontinued

operations 340
9.6.1. Other comprehensive income 340
9.6.1.1. Components of other comprehensive income 341
9.6.1.2. Changes in revaluation surplus 342
9.6.2. Discontinued operations 345
9.6.2.1. Definition and rationale 345
9.6.2.2. Scope 345
9.6.2.3. Measurement 346
9.6.2.4. Presentation and disclosures 348

9.7. Interim reporting 350

9.7.1. Interim reporting and accounting for income taxes 350
9.7.2. Determination of estimated weighted average
tax rate 354
9.7.3. One-time events or discrete items 356
9.7.4. COVID-19 impact 361

9.8. Convergence of US GAAP and IFRS; existing

differences in accounting for income taxes 362
9.8.1. Background of convergence 362
9.8.2. Differences in basic model 362
9.8.3. Differences in recognition and measurement 363
9.8.4. Differences with regard to specific items 364
9.8.4.1. Intra-group transactions 364
9.8.4.2. Revaluations of property, plant and equipment 366
9.8.4.3. Backward tracing 366
9.8.4.4. Foreign exchange differences on remeasurement 367
9.8.4.5. Unremitted retained earnings 367
9.8.4.6. Share-based payments 368
9.8.4.7. Uncertain tax positions 368
9.8.5. Differences in presentation 369

Chapter 10: Banks and Other Financial Institutions 371

Young Hwa An

10.1. Introduction 371

10.2. Specific tax accounting issues faced by banks 373

10.2.1. Branch structures 373
10.2.2. Financial instruments 375
10.2.2.1. Background 375

xvi
 Table of Contents

10.2.2.2. Asset accounting 376

10.2.2.3. Liability accounting 380
10.2.2.4. Example 381

10.3. Specific tax accounting impact of regulatory

regimes for banks 382
10.3.1. Historical reference 382
10.3.2. Role of the regulators 383
10.3.3. Overview of capital requirements under the
Basel Accords 385
10.3.4. The application of the Basel III Framework 386
10.3.5. Basel IV 388
10.3.6. Treatment of deferred tax assets under the
Basel Accords 389
10.3.7. US adoption of Basel III 395
10.3.8. European adoption of Basel III 395
10.3.9. Summary 396

10.4. Specific tax accounting impact of regulatory

regimes for insurance companies 397
10.4.1. Introduction 397
10.4.2. Insurance liabilities 398
10.4.3. Role of the regulators 399
10.4.4. Treatment of deferred taxes under Solvency II 400
10.4.5. Impact of COVID-19 408
10.4.6. Conclusion 409

Chapter 11: Case Study 411

Heather Jurek

Background 411

Additional information 411

ABC Foreign Subsidiary (FS) 413

ABC Global, Inc. consolidated financials 438

xvii
 Chapter 1

Introduction to Tax Accounting

Tjeerd van den Berg*

This chapter is based on information available up to 1 July 2020.

1.1. Introduction

For those seeking to embark on a journey to unravel the mystery of in-

come taxes, the necessary guide has arrived. This publication on account-
ing for income taxes under the International Financial Reporting Standards
(IFRS), will serve such travellers well on this journey. This publication
integrates an explanation of the essence of tax accounting, touching on pri-
mary tax accounting terminology, regulators, as well as other factors such
as the influence of media on income tax reporting, calls for transparency
and the International Accounting Standards Board (IASB), which publishes
the International Financial Reporting Standard. A 10-step methodology is
presented to correctly compute, determine and disclose the consequences
in the financial statement of a company.

Following this 10-step methodology, both newcomers and trained special-

ists will appreciate a framework presented for the calculation of the correct
income tax expense and preparation of the required disclosures. In addition,
all readers will be served well by the discussion of the theoretical back-
ground underlying significant income tax related questions and discussion
points.

To ensure that the theory discussed in the 10-step methodology directly con-
nects with actual practice, examples are offered that come directly from the
practical experience of the various authors. The first and foremost objective
is to explain clearly to the reader a methodology regarding how to structure
the accounting for income1 taxes and to acquaint the reader with the theory
and background of the various dogmas in the income tax standard.

* Partner, Netherlands TRS practice & EMEA Tax Accounting Services leader, PwC.
1. This is irrespective of whether one is a preparer or an auditor of (the income tax
paragraph in) financial statements.

1
Chapter 1 - Introduction to Tax Accounting

In addition, the place that accounting for income taxes and the respec-
tive standard has in the current environment is depicted and explained.
The world has changed rapidly, and financial accounting – especially tax
accounting – attracts the attention of a variety of stakeholders compared to
the late 1990s. At the end of 2014, when the first edition of this publication
was published, tax transparency became a serious topic. It is fair to say that
the call for transparency is now louder than ever. An ever-wider variety of
stakeholders show an interest in how tax affairs are being managed and how
much companies pay. Public deficits due to COVID-19 support packages
will only trigger more public attention in tax affairs.

Finally, a publication that focuses on accounting for income taxes under

IFRS would not be complete without an explanation of the position that
these standards have in the world of financial accounting. Furthermore, the
topics considered here require an explanation of the organizational structure
and procedures applied by the standard setter – the IASB – to arrive at a new
reporting standard or interpretation thereof.

This chapter explains the importance of accounting for income taxes. Key
definitions will be presented, followed by an explanation of the 10-step plan
and thus the core structure of the publication. Next, various initiatives are
outlined that promote increased transparency and fairness in the payment of
income taxes. Finally, the discussion shifts to the IASB as an organization,
as well as the place that the International Financial Reporting Standards
have in the world of financial accounting and how the Standards came to
be in this position.

1.2. Importance of accounting for income taxes

Many people will ask what is the relevance or importance of accounting for
income taxes. The quick answer is that income taxes generally are one of
the largest line items on a company’s income statement. The more elaborate
answer is that there are differences between the rules2 that govern finan-
cial accounting and the rules that govern tax. Thus, the question concerns
whether those differences are permanent or temporary in nature and whether
these are reflected correctly in the financial statements. This is generally
seen as a complex exercise that needs to be performed by tax accounting
professionals.

2. For instance, IFRS.

2
 Primary tax accounting terminology

The complexity increases and, thus, the importance, if one looks at account-
ing for income taxes in the context of multinational companies. The main
reason is that tax law is applicable on a jurisdictional basis and differs from
one jurisdiction to the next around the world, while the rules that govern
financial accounting provide for a single set of reporting standards that are
globally applicable. This combined with the fact that income and other taxes
impact multiple areas of business, and are embedded through many line
items in financial statements, makes taxes and – therefore the accounting
for income taxes – a key risk area for many companies.

Tax accountants know and understand tax complexities such as transfer pri-
cing, cross-border issues, hybrid loans and transparent entities. Furthermore,
they know and understand the respective differences – either permanent or
temporary in nature – that can arise between the principles used for financial
reporting and those established by tax law. As can be seen in financial state-
ments – even in single-entity financial statements – the reported tax expense
seldom reflects the profit before tax multiplied by the statutory tax rate. Tax
accountants focus on those differences. Basically, tax accounting is the fine
art of connecting and reflecting the two worlds of financial accounting and
tax in the financial statements.

1.3. Primary tax accounting terminology

Before embarking on the tax provision process, it is helpful to understand
the objective of the accounting for income taxes standard. The International
Financial Reporting Standards3 explicitly state that their purpose is to pre-
scribe the accounting treatment for income taxes. Specifically, the question
concerns how to account for the current and future tax consequences of:
– the future recovery (settlement) of the carrying amount of assets (lia-
bilities) that are recognized in an entity’s statement of financial posi-
tion; and
– transactions and other events of the current period that are recognized
in an entity’s financial statements.

It is inherent in the recognition of an asset or liability that the reporting entity

expects to recover or settle the carrying amount4 of that asset or liability.

3. The standard that governs income taxes is IAS 12.

4. Also, the book value reported in the financial statements.

3
Chapter 1 - Introduction to Tax Accounting

A firm grasp of the most relevant (tax) accounting terms5 is also essential to
understanding the tax provision process. These terms are considered below,
following the structure of the financial statements. According to IAS 1,6 a
complete set of financial statements consists of the following elements:

– A statement of financial position as at the end of the period. When look-

ing at the statement of financial position (balance sheet) from a tax
accounting perspective, the emphasis is on current and deferred tax
assets and liabilities.7 Current tax assets and liabilities represent
amounts payable to, or receivable from, taxing authorities at the report-
ing date. These amounts are based on the taxable profit (or loss) for the
past and current period.

Deferred tax assets and deferred tax liabilities reflect the future tax
consequences of temporary differences between the carrying values (or
book basis) of assets and liabilities recognized on the balance sheet and
their respective tax basis.8 A deferred tax asset represents the amount
of taxes expected to be received or recovered in the future as a result of
(i) deductible temporary differences and (ii) the carry-forward of un-
used tax losses and/or tax credits. A deferred tax liability reflects the
amount of income tax expected to be paid/incurred in the future as a
result of the reversal of taxable temporary differences. All deferred tax
balances are classified as non-current.

– A statement of comprehensive income for the period. When looking at

the statement of comprehensive income (income statement) from a tax
accounting perspective, the emphasis is on current and deferred tax
expense.9 Tax expense/(income) is the aggregate amount included in the
determination of profit and loss for the period in respect of current and
deferred tax. Current tax expense/(income) is the amount an entity ex-
pects to pay/(receive) based on taxable profits/(losses) arising in the
reporting period. Deferred tax expense represents the amount expected
to be received and/or paid in the future as a result of temporary differ-
ences originating and reversing in the reporting period.

5. IFRS do not contain a single list of definitions. Rather, all individual standards
contain their own relevant definitions. Those listed here are predominantly found in IAS
1 and IAS 12.
6. IAS 1, para. 10.
7. IAS 12, para. 5.
8. The tax basis of an asset or liability is the amount attributed to that asset or liability
for tax purposes.
9. IAS 12, para. 5.

4
 Primary tax accounting terminology

– A statement of changes in equity for the period. When looking at the

statement of changes in equity for the period, the emphasis is on the
current or deferred tax expense or receivable that is recorded directly in
equity or in other comprehensive income (OCI), and thus not in the
statement of comprehensive income. This is because, under IFRS, cur-
rent and deferred tax is to be recognized outside profit or loss if the tax
relates to items that are recognized, in the same or different period,
outside profit or loss.10

– A statement of cash flows for the period. The statement of cash flows
provides information about the changes in cash and cash equivalents
during the reporting period, and requires that cash flows during the
period be classified as pertaining to (i) operating, (ii) investing or (iii)
financing activities. Income taxes are generally classified as pertaining
to operating activities. Additionally, cash outflows for income tax pay-
ments made to tax authorities during the reporting period must be sep-
arately disclosed in the statement of cash flows or in the notes to the
financial statements. In principle, cash flows arising from taxes on in-
come are to be classified as cash flows from operating activities.11

– Notes, consisting of a summary of significant accounting policies and

other explanatory information. From a tax accounting perspective, a
key aspect is the required disclosure notes on income taxes.12 For a
complete overview and discussion of the respective disclosures, see
chapter 8.

– Comparative information in respect of the preceding period as specified

in paragraphs 38 and 38A.

– A statement of financial position as at the beginning of the earliest

comparative period when an entity applies an accounting policy retro-
spectively or makes a retrospective restatement of items in its financial
statements, or when it reclassifies items in its financial statements. This
element does not have specific13 tax accounting relevance.

10. IAS 12, para. 61A.

11. IAS 7, paras. 35-36.
12. IAS 12, para. 79 et seq.
13. In addition to what is stated in sec. 1.3., under A statement of financial position as
at the end of the period.

5
Chapter 1 - Introduction to Tax Accounting

1.4. How are income taxes accounted for?

Because there is no checklist provided in IAS 12, this publication will

introduce a 10-step methodology to correctly compute, determine and dis-
close income tax consequences in the financial statements of a company.
Throughout the publication, detailed explanations and clear examples are
provided on all the individual steps that are to be taken to prepare correct
financial statements. The 10-step methodology is generally applicable to all
(international) financial reporting standards, and although this publication
is based upon the IFRS and the respective standard on income taxes (i.e.
IAS 12), this publication is useful for both IFRS, US Generally Accepted
Accounting Principles (GAAP) and local GAAP filers. Also, it does not
matter whether one applies the 10-step methodology as part of the prepara-
tion of financial statements or the auditing thereof. Lastly, once the finan-
cial statements of a company are prepared in accordance with IFRS,14 the
10-step methodology is generically applicable. Essentially, the methodol-
ogy is blind with regard to the number of entities and/or jurisdiction in
which a company is active. Indeed, the methodology is as applicable to a
single entity as it is to 500.

The 10 steps are presented in chronological order in the chapters of this

publication. Some chapters contain more than one step, but most deal with
a single step. The following steps can be distinguished:
– identify book-to-tax differences;
– calculate the current tax expense for the period;
– calculate any adjustments to prior years’ tax expense;
– calculate the deferred tax asset or liability as at the close of the report-
ing period;
– assess any deferred tax assets for recognition;
– identify, recognize and measure any uncertain tax positions;
– reconcile the income tax accounts;
– calculate the total tax expense/(income) and allocate to (i) the statement
of profit or loss, (ii) other comprehensive income or (iii) equity as ap-
propriate;
– prepare the effective tax rate reconciliation; and
– prepare the relevant disclosures.

These steps are explained below.

14. Or US GAAP.

6
 How are income taxes accounted for?

Step 1: Identify the book-to-tax differences (chapter 3)

The starting point for all tax (accounting) calculations is the “commercial”
profit before tax. Therefore, the first step is to identify whether tax law
demands or creates a difference in tax treatment as compared to how a
certain transaction was treated and recorded under the applied accounting
standard. Such differences are either permanent or temporary in nature.

Regarding the difference between permanent and temporary differences:15

– permanent differences will not reverse;
– temporary differences will reverse, in a future period;
– permanent differences are generally found on the income statement; and
– temporary differences are generally found on the balance sheet.16

There are multiple ways to identify permanent and temporary differences,

for example:
– understand the connection between the financial reporting carrying
value of items in the statement of financial position and the correspond-
ing tax basis;
– discuss transactions that occurred during the year (e.g. acquisitions,
divestitures); and
– review prior years’ tax returns and provisions for continuing differ-
ences (in Dutch corporate income tax returns, one can check for differ-
ences between the tax balance sheet and the book balance sheet).

Step 2: Calculate the current tax expense (chapter 4)

The second step consists of computing an estimation of the tax expense,

beginning with profit before tax as reported under the applicable reporting
standard17 and identifying both permanent and temporary differences. If the
corporate income tax return is not based on IFRS/US GAAP,18 but on an-
other local GAAP, it may be easiest to break this step into two parts: identi-
fying the permanent and temporary differences to estimate profit before tax
under the applicable local GAAP,19 and then identifying permanent and tem-
porary differences between local GAAP and taxable profits for the period.

15. For a detailed outline and discussion of this first step, see ch. 3.
16. This means that a proper understanding of how and where items are reported for
GAAP and IFRS purposes will aid in the effective application of IFRS and/or US GAAP.
17. Generally, IFRS or US GAAP.
18. Which is hardly the case.
19. Differences between local GAAP and IFRS/US GAAP are generally “temporary”
in nature.

7
Chapter 1 - Introduction to Tax Accounting

The calculation can be broken down as follows:

Profit before tax (IFRS/US GAAP)

+/− Permanent differences
+/− Temporary differences
= Profit before tax (local GAAP)
+/− Permanent differences
+/− Temporary differences
= Taxable Income
× Substantively enacted tax rate20
= Current tax expense21

Calculating the current tax expense is thus equivalent to preparing the cur-
rent year tax return. There is no guidance provided by IAS 12 for this pro-
cess. It basically comes down to applying (local) tax law to the current year
results. Examples of other items that impact the overall tax expense include
credits; offsetting losses; and different jurisdictions and their different rates.

Step 3: Calculation of adjustments to prior years’ tax expense:

Return-to-accrual adjustments and true-ups (chapter 4)

There may be a need to correct the calculated current tax expense as deter-
mined in previous periods. These adjustments could occur due to improved
and/or additional knowledge gained in relation to the tax position taken in
the published financial statements. Although not often seen in practice, the
author would like to introduce a different use of the terms “return-to-accrual
adjustments” and “true-ups”.

Return-to-accrual adjustments. A return-to-accrual adjustment is an adjust-

ment to a prior year’s tax expense before and/or upon filing the tax return.
There are estimates inherent in the tax provision process which may subse-
quently change due to subsequent rulings,22 a change in tax law or a court
ruling or – as is most often the case – because a more accurate calculation
is possible compared to the preliminary estimate that was used to calculate
the income tax expense at year-end. Ultimately, when the income tax return
is filed, the current and deferred tax balances recognized in the financial
statements must be updated to reflect the filing position. This may result

20. Under US GAAP, the enacted tax rate is to be used.

21. IAS 12, para. 5.
22. Meaning a specific agreement with the tax authorities, mostly as regards an item
that is subject to multiple interpretations.

8
 How are income taxes accounted for?

in adjustments to both current and deferred taxes payable/(receivable).

Adjustments made up to the ultimate moment of filing the corporate income
tax return are referred to here as return-to-accrual adjustments.

True-up adjustment. The author introduces an unofficial distinction between

an adjustment before and/or upon filing the return and an adjustment after
filing the corporate income tax return. This can arise, for instance, due to a
deviating income tax assessment, a tax audit or a closed compromise with
the tax authorities. All adjustments after filing the corporate income tax
return are referred to here as true-up adjustments.23

Step 4: Calculate the deferred taxes at the reporting date (chapter 5)

The recognition of deferred tax is based on the principle that the tax effects
of transactions recognized in the financial statements should be recognized
in the same period as the transactions themselves, even if recognition in the
income tax return is in a subsequent period. In this situation, when transac-
tions are recognized for financial reporting purposes in different periods
than the tax return, temporary differences are generally created.

It is inherent in the recognition of an asset or liability that the entity expects

to recover or settle the carrying amount of that asset or liability. If the recov-
ery or settlement of that carrying amount will make future tax payments
larger (or smaller), deferred taxes must be recognized.

An entity analyses each of its assets and liabilities by comparing the carry-
ing value with its tax basis. The carrying amount is the amount for which
an asset or liability is recognized on the balance sheet.24 The tax basis is the
amount attributed to an asset or liability for tax purposes. Generally, this is
the value attributed to an asset or liability in the tax return in determining
whether cash flows resulting from the recovery/(settlement) of the entity’s
assets and liabilities will be taxable/(deductible).

23. US GAAP uses true-up adjustments for all adjustments up to filing the corporate
income tax return, and uses prior-year adjustments for adjustments after the moment of
filing the corporate income tax return.
24. There is a difference between IFRS and GAAP, in that the IFRS carrying amount
is equal to the amount recognized on the IFRS balance sheet, while the local GAAP car-
rying amount is equal to the amount recognized on the local GAAP balance sheet.

9
Chapter 1 - Introduction to Tax Accounting

Deferred tax asset Deferred tax liability

Asset
(e.g. building, plant and Carrying amount < tax Carrying amount > tax
equipment) basis basis
Liability Carrying amount > tax Carrying amount < tax
(e.g. pension liability) basis basis

In this fourth step, the temporary differences that were analysed in Step 1
are multiplied by the appropriate tax rate to calculate deferred assets and lia-
bilities. The tax effects of unused tax losses and unused tax credits are also
identified and considered.25 Generally speaking, the change in an entity’s
deferred tax position on the opening and closing balance sheet dates (gener-
ally resulting from the origination and reversal of temporary differences in
the current period) is the deferred tax expense/(income) for the period. For
exceptions to this rule, see chapter 5.

Step 5: Measurement of the deferred tax asset (chapter 6)

Deferred tax liabilities are recognized for all taxable temporary differences,
subject to limited exceptions discussed in chapter 9.26 Deferred tax assets,
however, are recognized in the financial statements to the extent that it is
probable that sufficient taxable profits will be available against which the
deductible temporary difference (or tax loss or credit) can be utilized.27 For
this reason, an entity with deferred tax assets must evaluate its sources of
future taxable profit as part of its income tax provision process in order to
determine whether they must be recognized.

IAS 12 provides several criteria in assessing the probability that taxable

profit will be available in the future,28 namely:
– taxable temporary differences;
– taxable profits;
– losses that are identifiable and unlikely to recur; and
– tax planning opportunities.

25. IAS 12, para.13 (the benefit relating to a tax loss that can be carried back to recover
current tax of a previous period shall be recognized as an asset). IAS 12, para. 34 (a deferred
tax asset shall be recognized for the carry forward of unused tax losses and unused tax
credits to the extent that it is probable that future taxable profit will be available against
which the unused tax losses and unused tax credits can be utilized).
26. Ch. 9, para. 1, the initial recognition exemption.
27. IAS 12, paras. 34-36.
28. IAS 12, para. 36.

10
 How are income taxes accounted for?

Step 6: Analyse the uncertain tax positions (chapter 7)

Tax law is complex, and positions taken in the tax return can often be inter-
preted in various ways, leading to disputes with the tax authorities and,
sometimes, an assessment of additional tax being due. Common examples
of uncertain tax positions include dividends and/or the application of par-
ticipation exemptions, transfer pricing principles, interest deduction restric-
tions and the applicability of tax rulings.29

While an entity may have a technical basis for the position taken in the
filed corporate tax return, these tax positions may still be “uncertain” if
there is more than one way to interpret the applicable tax law as applied to
the entity’s facts or if there is uncertainty whether a taxation authority will
accept an uncertain tax treatment. If so, an entity needs to consider whether
it is necessary to recognize a tax liability30 for the respective uncertain tax
position.

Step 7: Reconcile the tax accounts (chapter 8)

Here, the tax accounts recognized in the balance sheet position are adjusted
to reflect the current year’s tax provision calculated in the steps described
above. This step can be just as simple as it can be complex. The final posi-
tion on the balance sheet is the difference between the starting position, the
payments/revenues and the calculated current tax expense. Attention needs
to be paid to the fact that only income taxes may be taken into account, as
well as that there could be numerous other effects31 that impact the position
during the year.

Step 8: Calculate the total tax expense (chapter 8)

The total tax expense is calculated as the sum of the total current tax expense
and the deferred tax expense. Deferred tax expense is equal to the difference
between deferred tax assets and liabilities.32 Logically, it follows that:
– as deferred tax assets increase, deferred tax expense decreases;
– as deferred tax liabilities increase, deferred tax expense increases;
– as deferred tax assets decrease, deferred tax expense increases; and
– as deferred tax liabilities decrease, deferred tax expense decreases.

29. That is, a specific agreement with the tax authorities.

30. Often called a provision.
31. For example, foreign exchange differences, investments, divestments, equity and
other comprehensive income recordings. For a more thorough explanation and sample
disclosures, see ch. 8.
32. This is the straightforward methodology.

11
Chapter 1 - Introduction to Tax Accounting

While the current and deferred tax expense from current year activities was
calculated in earlier steps, sometimes additional entries are required in order
to correct the
the tax
taxaccounts
accountsononthe
thebalance
balancesheet,
sheet,asasa result
a result
of of mispostings
incorrect post-
or other
ings minorminor
or other errors.
errors.

Step 9: Prepare a rate reconciliation (chapter 8)

In this penultimate step, which is to determine the effective tax rate recog-
nized in the income statement, it is necessary to make a reconciliation from
profit before tax multiplied by the statutory tax rate. The effective tax rate
is the total tax expense divided by the profit before tax. If the tax rate can-
not be reconciled, the overall tax provision calculation is not complete. The
effective tax rate is used to “prove” the income tax expense of a company,
and it is a key performance indicator for listed companies. The effective tax
rate is used by analysts, investors and other stakeholders to measure the tax
function and its performance. Already for this reason, it is a required and
significant disclosure in the financial statements.

The effective tax rate is calculated using the following formula:

Total tax expense (profit or loss)
x 100
(IFRS) Profit before tax

There are many different items that affect the effective tax rate, including:
– permanent differences;
– return-to-accrual and true-up adjustments;
– the change in an entity’s (un)recognized deferred tax assets;
– credits that directly reduce tax;33
– changes in tax liabilities recognized for uncertain tax positions;
– changes in applicable tax rates on the measurement of deferred assets
and liabilities; and
– jurisdictional rate differences.34

Once done correctly, the effective tax rate and the rate reconciliation are
useful calculations in determining whether all transactions have been
accounted for correctly.

33. E.g. R&D credits and withholding tax credits.

34. “Jurisdictional rate differences” is typically a US GAAP reconciling item. US
GAAP filers use the corporate income tax rate of the head office (most often, the US
corporate income tax rate of 35%).
21%). Therefore, in consolidation, differences are caused
by differences in the statutory rate of subsidiaries due to their different jurisdictions.

12
 Other factors affecting tax reporting: Looking beyond the accounting
requirements

Step 10: Prepare the financial statement reporting and disclosure notes
(chapter 8)

This is arguably the most crucial step. It leads to the determination of what
(additional) narrative and/or figurative information is required, as well as,
more significantly, the decision regarding what information is desirable for,
and of use to, (potential) investors. One question concerns what information
they wish to know and at what level of detail the company should provide
such information. This chapter deals predominantly with the requirements
as specified in IAS 12, paragraphs 79 through 88. It also presents some best
practices of disclosing taxes.

It is the application of these 10 steps that truly unravels the mystery of

income tax accounting because it reveals, step by step, how to connect the
commercial world with the tax world. It is meant to serve as a reminder not
to jump to any conclusions and thereby forget intermediate considerations.
In addition, the publication covers special items, such as the initial recogni-
tion exemption, outside basis differences, business combinations, share-
based payments, other comprehensive income and discontinued operations
(see chapter 9). Special attention is also given to the tax accounting specifics
for banks and other financial institutions (see chapter 10).

Chapter 11 contains a case study in which the 10-step methodology and

theory discussed here is applied, in order to determine the correct tax figures
and disclosure notes.

1.5. Other factors affecting tax reporting: Looking

beyond the accounting requirements

1.5.1. Introduction

This section will discuss other factors that currently affect and determine
the daily activities of a tax accountant, including the increased pressure on
corporations and their tax and finance departments, which do not have their
origin in the accounting and disclosure requirements under IFRS.35 Since
the beginning of this century, there have been other significant influences
that determine the debate on income tax reporting arising from jurisdictional
statutes, institutional investor pressure and media coverage. Especially the
latter is driven by public demands, based on the perception that multinational

35. See ch. 8.

13
Contact

IBFD Head Office

Rietlandpark 301
1019 DW Amsterdam
P.O. Box 20237
1000 HE Amsterdam
The Netherlands

Tel.: +31-20-554 0100 (GMT+1)

Email: info@ibfd.org
Web: www.ibfd.org

IBFD,
IBFD, Your
YourPortal
PortaltotoCross-Border
Cross-BorderTax Expertise
Tax Expertise